Question

On January 1, 2020, Winthrop Inc. entered into a lease agreement to lease equipment:

• 5-year lease term
• Annual lease payments are $10,000
• First payment is on January 1, 2020 and the other payments are on 31 December each year
• At the end of the lease the leased asset will revert to the lessor
• The asset’s economic life is estimated at 10 years
• Winthrop could have obtained equivalent financing from its bank at a rate of 5%
• Winthrop’s fiscal year end is December 31
• The equipment has a fair value of $70,000

Required:

1. Calculate the present value of the lease payments.
2. Prepare the amortization table.
3. Classify the lease agreement.
4. Prepare the journal entry(ies) for the lessee for the 2020 fiscal year related to the lease arrangement.

Answer 1

(a) Present value of lease payments

Year	Date	Lease	PVF 5%	PV
0	01-Jan-20	10000	1	10000
2	31-Dec-21	10000	0.91	9070
3	31-Dec-22	10000	0.86	8638
4	31-Dec-23	10000	0.82	8227
5	31-Dec-24	10000	0.78	7835
			Lease liability	43770

(b)

Lease amortization table

Date	Lease payment	Interest 5%	Principal	Lease liability
	(a)	(b)	( a - b)
01-Jan-20				43770
01-Jan-20	10000		-10000	33770
31-Dec-20		1689		35460
		( 35771 * 5%)
31-Dec-21	10000	1773	-8227	27232
		( 35460 * 5%)
31-Dec-22	10000	1362	-8638	18594
		( 27232 * 5%)
31-Dec-23	10000	930	-9070	9524
		( 18594 * 5%)
31-Dec-24	10000	476	-9524
		( 9524 * 5%)

(c)

Classification of lease agreement :

This lease is an operation lease as

• it does not transfer ownership
• it does not grant an option to purchase equipment
• the PV of lease agreement ( 43770 ) is less than fair value ( 70000 )

(d)

	Journal entries
Date	Account titles	Debit($)	Credit($)
01-Jan-20	Right of use asset	43770
	To lease liability		43770
01-Jan-20	lease liability	10000
	To bank		10000
31-Dec-20	Lease expenses	10000
	To lease liability		1689
	To right of use asset		8311